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The monetary system
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The Monetary System:What It Is and How It
Works
Money: Definition
Money is the stock of assets that can be readily used to make transactions.
Money: Functions
• medium of exchange:
we use it to buy stuf
• store of value:
transfers purchasing power from the present to the future
• unit of account:
the common unit by which everyone measures prices and values
Money: Types
1. Fiat money
– has no intrinsic value
– example: the paper currency we use
2. Commodity money
– has intrinsic value
– examples:
gold coins,
cigarettes in P.O.W. camps
The money supply and monetary policy definitions
• The money supply is the quantity of money available in the economy.
• Monetary policy is the control over the money supply.
The central bank and monetary control
• Monetary policy is conducted by a country’s central bank.
• The U.K.’s central bank is called the Bank of England (BoE)
, • To control the money supply, the BoE uses
open market operations, the purchase and sale of government bonds.
Financial Intermediaries
– A financial intermediary is a firm that takes deposits from
households and firms and makes loans to other households and
firms.
– The main financial intermediaries whose deposits are money are:
– Commercial banks
– Building societies
– Commercial Banks
– A commercial bank is a private firm, licensed under the Banking
Act of 1987, to take deposits and make loans.
– A commercial bank’s balance sheet lists the bank’s assets, liabilities
and net worth.
– Liabilities + Net worth = Assets
– Among the bank’s liabilities are the deposits that are the main
component of money.
Main UK Commercial Banks:
• HSBC Bank
• Barclays Bank
• Lloyds (HM Treasury holds about a 10% shareholding)
• Royal Bank of Scotland (HM Treasury holds a 73% controlling
share)
– Profit and Prudence: A Balancing Act
– The objective of a bank is to maximize the net worth of its
shareholders.
– To achieve its objective, a bank makes risky loans at an interest rate
higher than that paid on deposits.
– But the banks must balance profit and prudence; loans generate
profit, but depositors must be able to obtain their funds when they
want them.
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